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This Just In: Upgrades and Downgrades

A top stock analyst likes Altria. But is there a better buy out there?

At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

And speaking of the best...When it comes to picking winners in the stock market, few analysts hold a candle to Stifel Nicolaus. Ranked in the top 5% of investors we track on CAPS, most times when Stifel says a stock is going up (or down), it does just that. On average, that stock proceeds to go up (or down) about 9 percentage points more than the rest of the stock market, producing outsize gains for investors privy to Stifel's advice.

Pointing to a 5.6% decline in Altria's stock price since its recent November high, against a 3.2% rise in the S&P 500, Stifel sees an opportunity in Altria's shares. According to the analyst, the stock's relative value is now "attractive," and Stifel predicts Altria is about to embark on a run to $36 -- a price we haven't seen the stock hit since July. But is Stifel right about that?

Smoke 'em if you got 'em; buy 'em if you don'tBy all indications, it should be. After all, over the past five years, Stifel has recommended buying cigarette stocks exactly five times, and been right exactly five times. Literal 100% accuracy.

A record like that is hard to argue with, the more so when you consider that a lot of numbers seem to argue in Altria's favor. For example, Altria's 17.1 P/E ratio today is cheaper than the P/Es found at peers British-American Tobacco or Philip Morris International(NYSE:PM) (which Stifel also recommends, by the way).

17.1 times earnings also happens to be very close to the 16.9 P/E found at or Reynolds American(NYSE:RAI), despite the fact that most analysts expect Altria to outgrow Reynolds over the next five years. All this, plus Altria's generous 5.5% dividend yield, seem to argue in favor of the stock.

17.1 times earnings, in an industry where most companies cost quite a bit more, may not sound like a lot to pay for Altria, but it actually is. Why? First off, because while Altria may report "net earnings" sufficient to give it a 17.1 P/E, the company's actual free cash flow number is quite a bit lower than what the company appears to be "earning." Fact is, Altria only generates about $0.79 in real cash profits for every $1 of earnings it claims. As a result, the price to free cash flow ratio on this stock is actually closer to 21.4 than to 17.1.

Worse, even these numbers don't take into account the $11.7 billion in net debt weighing down Altria's balance sheet. Factor that into the equation, and the enterprise value-to-free cash flow on Altria jumps past 25. Suffice it to say, that's way, way more than you should be paying for a stock that pays 5.5% in annual dividends, and is growing earnings at just 7.6% per year.

Foolish final thoughtRelative bargain Altria may be, but when weighed on its own merits, the stock looks expensive to me. What's more, even if buying a "relative" bargain is what you're here for, there's still one final tobacco stock we haven't discussed yet, which looks even cheaper than Altria today -- and indeed, looks cheap enough to buy on its own merits. That company is Lorillard(NYSE:LO).

Carrying a lighter debt load than Altria does, and generating nearly as much real free cash flow as it reports for net income ($1.06 billion versus $1.1 billion), Lorillard has higher quality of earnings than its larger rival. It's also growing faster than Altria, with a posited long-term growth rate of 8.7%, selling for a lower P/E (13.9), and paying a dividend nearly as generous as Altria's, at 5.4%.

Meanwhile, Lorillard has positioned itself to profit from a new trend in nicotine addiction, namely, electronic cigarettes. Last April, Lorillard bought electronic cigarette pioneer Blu Ecigs, giving it a foothold in the nascent "vaping" market. To date, Altria has not matched that buy with an e-cigarette play of its own, giving Lorillard first-mover advantage. When combined with stronger free cash flow, a faster growth rate, and a lower stock price, Lorillard looks like a better bet than Altria to me.

Fool contributorRich Smithhas no positions in the stocks mentioned above.You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 374 out of more than 180,000 members.

Author

I like things that go "boom." Sonic or otherwise, that means I tend to gravitate towards defense and aerospace stocks. But to tell the truth, over the course of a dozen years writing for The Motley Fool, I have covered -- and continue to cover -- everything from retailers to consumer goods stocks, and from tech to banks to insurers as well. Follow me on Twitter or Facebook for the most important developments in defense & aerospace news, and other great stories besides.